THE FLOW OF HOT MONEY CONTINUES

INFLATIONARY expectations are picking up across all major economies. Rising commodity prices are presenting difficulties everywhere, but are particularly problematic for developing countries. Brazil raised rates last week and warned that additional tightening was likely. Annual inflation there is just shy of 6 per cent and their latest 50 basis point hike takes Brazil’s benchmark SELIC rate to 11.25 per cent. Such high yields continue to attract foreign investors, driving up the value of the Brazilian real, despite fresh currency controls. This is encouraging cheap imports and so hurting domestic manufacturers.

The People’s Bank of China (PBOC) has now raised its banks’ required reserve ratio seven times and hiked interest rates twice in just over a year. Yet despite this, the PBOC is considered to be well behind the curve when it comes to controlling inflation. Last week, Chinese data showed that their PPI is running at around 5.9 per cent and CPI at 4.6 per cent. Yet the official lending rate currently stands at 5.81 per cent and is not yet high enough to dampen speculation. China has certainly been less aggressive than Brazil when it comes to tightening.

Wages are rising dramatically, and there are hopes that this will not only curb anger at rising food prices, but also lead to a general increase in living standards and domestic consumption. But rising food prices are a serious concern and there is evidence that these are not properly reflected in the country’s inflation data. After all, last week’s data indicated that inflation was moderating, even as GDP (at 10.3 per cent for 2010) expanded over the same period.

Chinese policymakers are anxious to encourage continued growth in manufacturing and exports, and for this they need a cheap currency. However, they also need to keep a lid on inflation. This is a hugely important issue for China, and also for a significant number of foreign investors. Many have pinned their hopes on continued strong economic growth in the country. Hot money has flooded into China and other Asian Pacific countries, attracted by high yields and the promise of strong growth. Yet the Shanghai Composite is down over 5 per cent so far this year, following a fall of 12 per cent in 2010. So the question continues to be whether this represents a good buying opportunity, or a warning of more pain to come?